Venture Capital: Challenges with Investing in Internet Companies

The change of technology in software and the Internet is astounding. This is perhaps one of the greatest reasons using venture capital to invest in Internet and software companies is extremely difficult. Internet companies also face the struggle of retaining and keeping good talent from a somewhat limited pool and often incur time management issues as limited resources and market trends can quickly divert entrepreneurs from the original business plan. In addition, complete scalability of Internet businesses often creates a growth risk, wherein companies which grow too fast are unable to keep abreast of the expansion and eventually implode. Further still, having the discipline to adhere to a very strict plan can be difficult for Internet companies seeking to make a buck in an industry of constant flux.

Staying abreast of the hundreds and even thousands of engineers who’re simultaneously seeking to solve working problems and technical challenges within IT can be a nightmare in and of itself. The pace can be so rapid that many managers, investors and board members find it difficult to keep up. Failing to do so can mean a company may be attempting to reinvent the wheel unnecessarily.

The challenge for many entrepreneurs in the information technology space is combine great operations execution with the right strategy. In the fast-paced market that is the Internet and with funding-cycles only ranging in the 12 to 18-month space, Internet companies will need to nail their strategy early. Investors and managers will also need to be cognizant of the ever-present need to steer away from too much change and not enough focus. Razor-sharp focus is what will cause businesses to win.

Exit Strategies

Because broader company valuations are present in software investment banking, your particular firm’s valuation may be entirely dependent on how the company is viewed by the acquirer and how strategic the acquisition may be based on competitive market forces. If your value added features or clients represent a huge synergy as a target for the acquiring company, multiples may reach double digits, otherwise you’ll probably be seeing multiples in ranges which more accurately mirror legacy businesses.

In general, companies don’t have exit strategies–investors do. When a company sells the only thing that occurs is a change in the ownership of the firm. Management, in many cases will remain intact–at least for a time of transition–until other details are worked out. The entire idea of a company will continue on, even after any type of liquidity event. The goal is to do so at the highest multiple or return on investment. In fact, one of the biggest struggles of VCs and software companies occurs over the fact that most software companies are not profitable enough, fast enough. In other words, they were not taken to a point of scale in a short enough period of time. If your software company does not reach profitability rapidly and before an exit, there is not a high likelihood of the company being sold. Unless the deal is accretive, the company is not going to be sold.

Because most venture capitalists are focused on big-wins in software to compensate for some of the huge write-offs they face, your story will, of necessity, need to not only be compelling enough to obtain funding, but also scalable and sustainable enough to get legs and provide some type of liquidity event for both investors and founding entrepreneurs. While this event is rare for many founding entrepreneurs, investors know they will probably have a number of failures before they see a complete success story.

Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.

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